A quick look at the price history of most types of voluntary carbon credits in 2021 and 2022 will reveal a slightly right-skewed bell-shaped curve.
It is a form that tells a very simple story: much of the value that carbon credits quickly gained in 2021 was slowly but surely lost in 2022. It is a form that has market players wondering what would come next – and the same line might provide the answer.
Too expensive to hold
The onset of the Russia-Ukrainian conflict and the energy crisis were the main causes of the prevailing bearish sentiment in the voluntary carbon market.
In the immediate aftermath of the Russian invasion of Ukraine on February 24, 2022, several market players were heard exiting their positions in the VCM as they were attracted to more volatile and lucrative oil and gas markets. At the same time, cash-strapped companies rushed to reduce their risks.
But after bottoming out in March when the US imposed a ban on Russian oil imports, VCM prices appeared to be stable in April and early May. So after this stability period comes something worth looking at if we want to gauge what lies ahead for the VCM.
At the beginning of June, a new bearish trend in the VCM started, including in the most liquid segments of natural and renewable energy. This coincided with the US Federal Reserve preparing to announce something trade desks hadn’t heard in a while: a rate hike.
The rate hikes changed investment scenarios. In voluntary carbon markets, higher rates meant that it had suddenly become too expensive to hold on to VCM positions held by secondary market players in the hope of further price increases. Since carbon credits do not expire and can be traded multiple times until they are finally used to offset certain emissions and retirees, secondary market players such as traders or financial players have become accustomed to buying and holding credits of recent vintage keep it until it can sell for a higher price.
While the general perception of the market remains bullish in the coming years and demand from companies committed to net zero targets is expected to increase, higher interest rates mean that this “hold game” has now become riskier or more expensive.
The extent to which secondary market players will expand their holdings in the market in 2023 – and the extent to which the VCM will emerge from the quagmire where it appears to have fallen – will still largely depend on changes in interest rates and the cost of holding of positions.
Time for regulators to shine
Another part of the 2022 price curve brings us to an even more important factor to look at for 2023 projections.
In the fall of 2022, as the UN Conference on Climate Change, or COP27, approached, a new bearish trend appeared in the VCM.
After a few late summer weeks with high expectations of new demand coming to the market, very much in line with what happened last year at COP26, market players started to face the harsh reality. They began to realize that their expectations of clear rules being set at the UN summit on carbon credit mechanisms would not be met, and that – amid this regulatory uncertainty – most buyers chose to postpone their purchases .
This resulted in a slowdown in market activity and price losses in all segments.
Players had hoped that COP27 delegates would make decisions about what type of projects would be allowed under the yet-to-be-launched Article 6 credit scheme, and clear definitions of what constitutes a high-value carbon credit. But none of this came to pass as the deputies deemed it necessary to allocate more time to make these decisions and pledged to continue their talks in 2023.
The voluntary carbon market has yet to recover from the impact of this regulatory uncertainty. Much of what will happen in 2023 will depend heavily on more clarity on what makes a carbon credit a good quality credit, as well as when companies are allowed to engage in voluntary carbon markets without risking accusations of greenwashing.
A number of organizations are working on guidance, including the Integrity Council for the Voluntary Carbon Market, the Voluntary Carbon Market Integrity Initiative and even the International Organization of Securities Commissions – which launched a 90-day public consultation at COP27 on the role of a potential financial framework to promote market integrity.
Rating agencies will play an increasing role in assessing the effectiveness of carbon projects in avoiding, reducing or removing carbon and thus in assessing the quality of the carbon credits provided by these projects.
But the sooner a clear and mandatory framework becomes available, the better for the VCM. In particular, only clear and mandatory rules on when companies can resort to carbon credit mechanisms and offsetting practices to meet their net zero targets will create that space for players to enter the market with confidence.
It is essential that end customers are required by mandate to commit to a serious and science-based program to reduce their avoidable emissions before resorting to carbon credits to offset unavoidable emissions. net-zero targets without hindering the transition to a cleaner economy.
With more clear rules, the VCM will thrive in 2023 and years to come. Otherwise, it may be destined to stay in “limbo” a little longer.